In October of 2004, President Bush signed into law the American Jobs Creation Act, which includes a tax benefit for certain domestic production activities. The production activities that qualify run the gamut, from software development to construction of residential and commercial buildings to engineering and architectural services.
One common thread that runs through the legislation is that the goods and services must originate in the United States. That’s a stipulation that can benefit middle-market manufacturers that don’t have global operations scattered across the world, says Colleen Taylor, a senior manager at Vicenti, Lloyd & Stutzman LLP.
“The spirit of the law was designed to help out small manufacturers that are engaged in domestic production,” she says.
Taylor spoke with Smart Business about how businesses can take advantage of the new law and why it is crucial for manufacturers of all sizes to educate themselves about the changes.
What is the underlying goal of the new tax deduction for manufacturing activities?
Primarily, this tax deduction came as a result of a repeal of the Extraterritorial Income Exclusion. That exclusion was ruled as an illegal subsidy by the World Trade Organization about four years ago, and the American Jobs Creation Act of 2004 provided for the new deduction for U.S production activities. It is designed to give U.S. manufacturers a break for domestic production activities versus going overseas.
What steps can a business owner take to capitalize on the tax changes?
The number one step is to identify what their domestic production gross receipts are and to determine if there is an allocation that is going to be required. The new deduction is effective for the period beginning after December 31, 2004, so anyone with domestic production activities in the year 2005 would definitely be able to benefit from this.
Businesses need to start doing their homework, as far as identifying domestic gross receipts versus other gross receipts. Also, they have to identify the costs related to those domestic gross receipts. The best thing to do would be to read some of the guidebooks put out by the U.S. Treasury Department.
They can go to the U.S Treasury Web site to get guidance and look at the fact sheet on Section 199, which provides a really good overview. This is a good place for manufacturers to get started to see if this affects them and what steps they should take.
What constitutes manufacturing activities?
This law has been defined very broadly to include not only traditional manufacturing, but also engineering, energy production, computer software, construction activities and processing of agricultural products. It’s a very broad, broad range for manufacturing.
In what ways can a business benefit from these tax deductions?
Businesses as well as individuals, corporations, partnerships, trust and estates can take advantage of this credit. The deduction is based on the profit from domestic production activity and therefore the more they produce domestically, the more their deduction will be, up to a limit. They’re limited to 50 percent of the W-2 wages.
Congress has enacted safe harbors to ease the burden of calculations. Why is this so important to small manufacturers?
The small manufacturer is so overwhelmed. They usually don’t have the expertise in-house and a lot of times can’t afford to pay for somebody to do a lot of very difficult calculations. So Congress has provided some de minimis rules and simplified formulas to assist small taxpayers in determining their taxable income from the qualifying activity.
The de minimis rules, for example, state that if less than 5 percent of a manufacturers’ gross receipts are from nondomestic production, they are able to include their total gross receipts and they don’t have to separate it out. Also, they have simplified formulas for determining the W-2 wage limit. There are three different methods and there is a simple method that people can take advantage of.
The problem with the small manufacturer is that if the process is too difficult or takes too much time to calculate, they’re not going to take advantage of it. It’s important that small businesses talk to a tax professional and educate themselves so they can take advantage of the credit.
How will the deduction be phased in?
It’s going to be phased in over a period from 2005 to 2009. So for the years beginning in 2005 and 2006 it is 3 percent. For 2007 and 2008 it will be 6 percent. Then for years beginning after 2009 it will be 9 percent. There again, it is still limited to 50 percent of the W-2 wages.
Colleen Taylor is a senior manager at Vicenti, Lloyd & Stutzman LLP, a business consulting and CPA firm based in Glendora, Calif. She plans, directs and supervises accounting and consulting services for the firm’s corporate and individual tax clients. Reach her at (626) 857-7300, ext. 248 or firstname.lastname@example.org.